Chevron Could Take Big Hit From Potential Payout in Ecuador

The appeal is over a fine payment of $8.6 billion plus an additional 10% as compensation to claimants. The charges stem from Texaco's (acquired by Chevron in 2001) operations in Ecuador between 1964 and 1992.

Chevron is one of the largest energy companies in the world, and competes with other established oil producers like Exxon Mobil, ConocoPhillips, BP and Anadarko.

Our price estimate for Chevron stands at $104, roughly in line with the stock's market price.

While there is no certainty as to which side will prevail in the appeal, it is worth taking a look at how Chevron's value could be affected if it is ordered to pay the maximum fine.

The case charges Texaco with causing environmental damage in Ecuador prior to Texaco's acquisition by Chevron in 2001. The people of Ecuador initiated litigation against Texaco in 1993, suggesting that the company dumped oil-drilling waste in unlined pits, damaging the Amazon forest and harming the living species in the region. Chevron asserts that the waste pit sites were cleaned up before being handed over to Ecuador's state-owned oil firm.

The $9.5 billion potential payout appears to be the biggest environmental battle ever fought by an oil company. Before this, Exxon Mobil had to pay $4 billion for its role in the accidental spilling of oil near Alaska. BP has paid close to $3.5 billion so far for the damage stemming from an accident at its drilling rig in the Gulf of Mexico.

Assuming a scenario in which Chevron is ordered to pay the maximum penalty of $9.5 billion, the reduction in cash would decrease its equity value by approximately 5% (on our estimates). This scenario would drop our $104 price estimate for Chevron stock down to about $99.

While this particular impact would be a one-time charge, long-term impacts could include tighter anti-pollution regulations and stricter enforcement. This would likely raise costs for oil companies, an affect that would be reflected in profit margins.